Reflections on Tens Years of Value Investing

It’s been 10 years since I started practising Value Investing and it’s time to do a little introspection and write down a few reflections. I hope these reflections can serve as a memory aid to my future self and be of value to others as well.

I have always had an affinity to investing because of my upbringing. I opened my first trading account soon after I graduated from uni. After a year or so of study and experimentation, including a few confusing months mucking around with heads-and-shoulders and candle sticks ;), I soon discovered the Value Investing approach, which immediately appealed to me. The central ideas of Value Investing, that of valuing a business within one’s circle of competence and buying only when there’s a margin of safety, simply made good logical sense to me.

The value investing approach works for me: from 1 Sep 2006 till now (Sep 2016), I have achieved compounded return of 12.64% per annum, which is quite a bit better than many standard benchmark returns over the same period. (My track record on Australian shares is significantly better at 16.3% per annum.) This is not bad for a novice although the money I was handling in the initial years leading into the GFC period was quite small.

I will now try to pick apart some of the factors that contribute to and detract from my investment performance.

Lesson 1 : The Macro Environment Matters

There is a school of thought in Value Investing that macro economic analysis doesn’t matter, backed up by this Peter Lynch quote: “If you spend more than 13 minutes analyzing economic and market forecasts, you’ve wasted 10 minutes.” I think a key lesson from the GFC is that this line of thinking is flawed, and that a bottom-up company analysis needs to be balanced with a view on the broader economic environment. Indeed, a major source of my return comes from currency gain. Informed by a view on the likely unsustainability of a high Australian dollar — a view shared by several well-known value investors at the time — I converted a significant percentage of my Australian dollars into US dollar-denominated holdings (both cash and equities) around the time when Aussie dollars and the greenbacks were trading at near parity. It was a defensive hedge that ultimately added to my overall return and also protected me from some poor stock selection decisions, and there were of course a few such decisions.

Lesson 2: Taking a Long-Term View is Hard

Markets are not 100% efficient but it is pretty close. The two main forms of arbitrage available to a value investor are

emotional arbitrage – being able to keep calm and buy when everything around you is falling apart and, conversely, being able to remain sane and sell when everything looks rosy and risk-free;

time arbitrage – a lot of investment cases take the form of “if something cannot go on forever then it will end” but it’s usually not possible to predict when the end will arrive so being able have one’s money locked up for at least 3-5 years, possibly longer, is important.

One needs the right temperament and an ability to take a long-term view to successfully execute these two forms of arbitrage. Some people are born with the right temperament while others need a lifetime of cultivation to get close. Being able to take a long-term view is, however, something that everyone ought to be able to set themselves up to do but it’s hard for a couple of reasons:

A prerequisite of being able to take a long-term view with an investment is that the money invested needs to be “patient money”, which usually takes the form of surplus cash that can be locked up for extended periods of time. By definition, anyone with a mortgage doesn’t have surplus cash.

The second reason taking a long-term view is hard is captured by this Blaise Pascal quote: “All of humanity’s problems stem from man’s inability to sit quietly in a room alone.” If one takes a long-term view, the correct action in most cases is “do nothing”. However, doing nothing is incredibly hard when the whole finance industry, with its second-by-second tick prices and incessant “expert” commentaries on markets and stocks, are there conspiring to get you to trade as frequently as possible. (If you are one of those people that check your portfolio 20 times a day then you know what I mean.)

I must admit to personal struggles with taking a long-term view. Looking back at the last 10 years, the biggest mistake I made consistently are selling my winners too quickly, which is in part because I didn’t have surplus cash in the early years, but mostly because I’m horrible at “doing nothing”. I read quite a lot, which compounds the problem because it’s psychologically hard to “do less” when you think you “know more”, even though knowing more doesn’t necessarily help in what is ultimately a game of chance. (That’s life.) Interestingly, having a hectic job is what ultimately helped me to achieve behaviour consistent with long-term thinking in investing. Note to future self: find another way to keep a distance from the market place when you’re retired.

Lesson 3: Make Sizeable Bets

A key principle of value investing is that there should be no difference between buying a small parcel of a company and buying the whole company; the same due diligence should be applied. In practice, if the parcel one buys is too small, then it’s human nature to take intellectual short cuts or even mistake a fun, speculative bet as a proper investment. To avoid such mental lapses, it’s useful to have a simple rule that each investment must be sufficiently large to be painful if one gets it wrong. The right number is different for each person, but this should ideally be a percentage of one’s portfolio as it grows. Anything that doesn’t move the needle on the portfolio size is, in my view, too small.

Lesson 4: Prefer Steady Growth to Cyclicals and Turnarounds

Outside widespread market panics when everything is on fire sale, the kind of market events that draw the intention of value investors often involve cyclicals and turnarounds. I have my fair share of successes in such situations — indeed, my first major win come from a concentrated position on Malaysian palm oil companies when the CPO price was in the RM1,600 range; the CPO price duly went up to the RM3,500 range, allowing me to pay the downpayment for my first house — but also the occasional disasters, including one that may still be brewing at this point (it’s still too early to call on that one but the first rise in Macau gaming revenue in 27 months, if sustained, may yet save the day). My sense is that there are too many value traps among cyclicals and turnarounds, and the emotional experience of holding those stocks is usually unpleasant even when things eventually work out. It’s more pleasant and easy to hold on to companies like Berkshire Hathaway, which has a simple investment case that more-or-less guarantees high-single-digit to low-teen annual growth for the next decade or so, or, for that matter, Sydney Airport. Boring, steady growth that is easy and pleasant to hold on to is my definition of an investment good life.

So those are the key lessons I picked up in 10 years of practising value investing as a novice. I hope you don’t forget them, future me. 🙂